Trading 101: An Introduction to Derivatives

You have a lot of choices when you enter the world of trading and when you make trading your career. All of such choices will give you rewards and benefits. Each of them offers special rewards if you do them right. And aside from stocks, currencies, commodities, Finance Brokerage Educationand others, you can also choose derivatives.

Derivatives are powerful and highly profitable financial instruments that can make you rich if you know how to handle them Forex Trading Guide properly each time you choose to trade with them.

In this article, we’re going to breakdown what derivatives are and what you always have to remember if you decide to make derivatives your financial instrument of choice.

What are derivatives?

If you follow financial news, you would probably hear the words “derivatives markets” and “financial derivatives.” Well, that’s one sign that they are indeed very powerful and popular among traders and investors.

And if you don’t know about them yet, it’s not too let to catch up.

You got so much to gain from derivatives. More and more traders are becoming hooked to derivatives because of their ability to give huge profits to those who use them.

Derivatives are basically contracts, or agreement between two parties. It is an agreement between a buyer and a seller. Both of them will agree on the future price of an underlying asset. Remember that both of the parties involved in such agreement should also agree on a specified future date.

One very important factor in such contracts is the price change in the underlying asset used in the derivative. The underlying asset can be any asset like stocks, currencies, properties, commodities, et cetera.

The agreeing parties “derive” the value of the contract based on the fluctuation of the underlying asset’s market price.

Obligations vs. Rights

There are many kinds of derivatives. To name a few, there are futures, forwards, options, and swaps. These four are the most commonly traded derivatives on the market.

In derivative contracts, the actual trade takes place on the predetermined future date. Now, the main difference between each kind of contract lies in the parties’ rights and obligations to follow through the agreed buying or selling date.

Some contracts bind both the buyer and the seller to the contract. This means that both of them are obligated to execute the trade on the agreed date.

Meanwhile, there are contracts that bind only one party to push through the contract, but the other party won’t have any obligation. The party that’s not bound by the contract has the rights, either to buy or sell, but is not obliged to do so.

Zero-sum game

When we say something is a zero-sum game, it means that one party stands to gain something as another party stands to lose. They cannot be both benefitting from an outcome. Derivative contracts play a zero-sum game.

This means that if you win the trade on a derivative contract, the other party loses. If the other party wins the trade, you will lose. In other words, in a derivative contract, you and the other party are practically wagering against each other.